Federal Reserve Chairman Ben Bernanke said the economic recovery is “far from satisfactory,” and as a result, the Fed “should not rule out” new policies. However, Bernanke stopped short of outlining the specifics of any moves. In other words, QE3 did not sail today.
The speech was far different from the one two years ago, when Bernanke gave investors a gift from the Grand Tetons. In articulating the various options available to the Fed to spur economic growth in 2010, Bernanke mentioned one that stole the show: A second round of “large-scale asset purchases”, also known as “quantitative easing.”
Here’s how the operation works: The Fed buys U.S. Treasury bonds and mortgage-backed securities, which drives up prices, pushes down interest rates and reduces the availability of these bonds in the market. With fewer bonds available, investors turn to alternate assets, like corporate bonds. When the original QE was announced in March 2009, the economy was shrinking by an annualized rate of 5.3 percent and companies were having difficulty borrowing money. QE helped grease the wheels of corporate credit and helped the economy function more normally.
When QE2 was announced, corporate credit was not the issue, but a downshift in economic growth was worrying the Federal Reserve. The second round of quantitative easing was seen as a way to boost the economy, which was only growing by about 2 percent. While QE2 may not have moved the needle too much on growth, it sure did move the stock market. Investors jumped on the August 2010 speech, plowed into stocks before the plan was formally announced in November; and the stock market subsequently rallied 28 percent over the next eight months.
The Jackson Hole speech does not mean that the Fed will sit on its hands at the next policy meeting in September. After all, Bernanke noted that persistently high U.S. unemployment is a “grave concern” and that the Federal Reserve will provide more help if the economy doesn’t improve. In addition to QE3, the Fed could also lower the interest rate it credits to banks. Currently, when banks keep their money at the Fed, the Fed pays them 0.25 percent interest. The Fed could drop the rate to zero, which might encourage banks to do something else with the money, like lend it.